Economic explorations

Post navigation

Company profits and efficiency

A fundamental element of business is profit as an incentive to advance a company forward. In economics, it is essentially revenues less costs, where positive profits come companies seeking to increase revenues and reduce costs.

While this may be the case, companies appear to look towards immediate returns to show shareholders that they are “profitable”. This drive to show profitability means that companies are reluctant to make longer term decisions to maintain profitability since there are risks of making a wrong prediction. Why take a chance when you can have a sure thing?

So, if there is lots of short-term thinking, how does one look for long-term profitability? From Investopedia, Richard Loth has developed a university primer on profitability indicators (see Profitability Indicators). Many of the measures are calculated annually, with trends examined year over year, typically over a 3- to 5-year period to get a long-term trend.

While the market uses these measures, one wonders if there are other measures out there to look at a company (and an industry) from another perspective. How well does it use its physical capital? How much energy is employed? How much is spent on waste? These are efficiency measures, and not profit measures. Company efficiency measures are usually focused on inventories as this can indicate sales patterns. But, if machinery and infrastructure is a significant part of a company’s costs and liabilities, these may offer some additional clues about the “efficiency-mindedness” of a company.